To inform, confuse, and enlighten; in economic matters as well as philosophical ones. Jørund Aarsnes and Stephan Jensen write on economics and the human condition.

The Future of Capitalism (and economics)

by Stephan

The opening session today in the ongoing OECD Forum 2010 was on the future of capitalism, where economic historian Anatole Kaletsky argued that “we’re entering a new period of pragmatism, when ideology will give way to a more “common sense” approach.” Arguably, this is not such a radical notion; the financial crisis has shown in a dramatic way that there have been some serious cracks in what has commonly been accepted as “good” economic policy. It is easy to blame greed and carelessness in the financial sector, but that hardly goes to the heart of the problem. At the end of the day, even if the greed and carelessness of a few “evil bankers” really is to blame, policy has to change if the economic structures have been conducive to making it cause despair for millions of people.

Aside from highlighting dysfunctional economic structures and the need for reform, a very immediate consequence of the crisis is that Governments have been taking a much more active role in the world economy through financial sector bail-outs, stimulus packages, nationalization of ailing industries, and ad-hoc policy measures such as temporary taxes on banker bonuses and bans on short-selling. Most recently, the Euro-Zone bailout of Greece – complete with stringent demands for fiscal reform and at least some degree of budgetary control from Brussles – is the last example of how this plays out.

That kind of direct market participation, though, is perhaps more a matter of economic politics than economic policy. And while we are arguably not yet near the end of heavily indebted governments being major players in turbulent financial markets, I think it is unlikely that this situation will be politically sustainable beyond the recovery, and I do not think this is what Kaletsky is referring to when he talks about a return to less ideological “common sense” economic policy. Rather, it is an issue of how the political-institutional structure modern capitalism rests on should and will be reformed.

This is not a matter that can be understood in naive terms of “government versus market”, but rather an issue of how markets and capitalism function in the first place. Of course, some believe that the best possible institutional underpinnings of a well-functioning market will appear as if by magic if only governments would disband and leave everyone alone. Nevertheless, most if not all countries where this experiment has been tried in one way or another are commonly referred to as “failed states“. The strength of the economy and capitalist system in Somalia, for example, can tell us much about the quality of the market-supporting institutional structure that spontaneously emerges in anarchy. The country does have a booming “maritime” industry, though, and as the quote below from Foreign Policy magazine describes, a well-functioning and liquid weapons market:

…Mogadishu’s Bakara Market, the country’s largest open-air forum. Sellers and buyers used to be well-stocked with food staples and other daily essentials. Today, the strongest product line is weapons — everything from handguns to rifles to rocket-propelled grenades. Such arms have been the quickest means to power and subsistence in Somalia since chaos erupted 18 years ago. As Somalia claimed the No. 1 slot on the Failed States Index for a second year in a row, militant attacks had forced the country’s fledgling transitional government literally into a corner; by December 2008, it controlled merely a few blocks in a country of 627,000 square kilometers.

We here at Evolution-Revolution certainly think it is a good thing that the subject of economics gets shaken up a bit, and hope that it is becoming much more intellectually diverse than it has tended to be in the last forty years or so. I have written a piece before on what I call the Smorgasbord Approach to economics. George Akerlof and Joseph Stiglitz also agree with me that more diverse economics means better economics.

Notwithstanding, while Kaletsky is proclaiming that we now are entering a period where the approach to economic policy will be more pragmatic, I would argue that economic policy in the western world was never really that ideologically driven in the first place. Policy makers labeling themselves as “conservatives”, “liberals”, “socialists”, or whatever tag you want to put on it have by and large always ended up promoting a kind of middle-of-the-road pragmatic capitalism that is very far from what one might call a “free market” in the libertarian/anarchist sense, as well as any kind of real “socialism”. As an example, Norway’s last minister of finance, Kristin Halvorsen, came from the rather radical sounding “Socialist Left Party”. Nevertheless, Norway remains one of the world’s most open capitalist economies, ranking close to the top in the World Bank’s “doing business”-index, and is home to capitalist multinational corporations such as Telenor (the world’s seventh largest wireless telecommunications provider) and Statoil. The supposed minister of finance supposedly belonging to the “socialist left” never once mentioned the issue turning over ownership of means of production to the proletariat, but fought hard for better, cheaper, and more accessible kindergartens – arguably one of the most effective ways of increasing female participation in the capitalist labor market. At the same time, “conservative” governments in the U.S. have been spending billions of dollars on all kinds of market-intervening programs, far from what is thought of as the ideal case both in standard economics textbooks and amongst right-wing ideologues. Dani Rodrik elaborates on this in a blog-post previously linked to by my co-author:

In fact, industrial policy never went out of fashion. Economists enamored of the neo-liberal Washington Consensus may have written it off, but successful economies have always relied on government policies that promote growth by accelerating structural transformation….But when it comes to industrial policy, it is the United States that takes the cake. This is ironic, because the term “industrial policy” is anathema in American political discourse. It is used almost exclusively to browbeat political opponents with accusations of Stalinist economic designs.Yet the US owes much of its innovative prowess to government support. As Harvard Business School professor Josh Lerner explains in his book Boulevard of Broken Dreams, US Department of Defense contracts played a crucial role in accelerating the early growth of Silicon Valley. The Internet, possibly the most significant innovation of our time, grew out of a Defense Department project initiated in 1969.

Nevertheless, the most important point here is not that particular policies are more or less pro “free-market” or pro “big-government”, but that a policy-paradigm based on the understanding that economics, policy, and institutions are far from separate; but also on the idea that capitalism in some form is most desirable. Even more importantly, it is based on the understanding that there is no such thing as a context-independent platonic ideal type capitalism associated with a set of unchangeable and derivable policies that can easily be imposed anywhere. As the Epicurean Dealmaker writes:

I am a dyed-in-the-wool capitalist and investment banker. Unlike many of my fellow citizens at the moment, I continue to believe both of these are good things, and better than the alternatives. Nevertheless, I acknowledge, apparently unlike many of my blinkered brethren, that there is a good way to run capitalism and investment banks and a bad way.

This basic idea – that there are many different ways to do capitalism, markets, and business – is in a sense contrary to the ideologically driven style of economic policy and capitalism Kaletsky refers to. I think there is little evidence, though, that it really ceased to be an underlying assumption in western-world policy making after Reagan and Thatcher.

There are two very important exceptions to this: financial regulation and development economics. The financial crisis is to some extent evidence of the former, with basket-cases such as Iceland as horrid examples of how badly ideologically-driven policy can go. I am sure that many Icelandic people would wholeheartedly agree with TED’s quote above. Certainly, it would be grossly unfair to call someone anti-market or anti-capitalistic for arguing that Iceland should have had a more regulated financial sector in the years preceding its total financial annihilation in 2008. Actually, Iceland’s capitalism would most likely have been a lot better off today had in not been for the hardcore ideologically driven financial-sector liberalization set in motion by its conservative Sjálfstæðisflokkurinn (Independence Party) at the beginning of the decade (a forthcoming paper by Baldur Thorhallsson, Iceland’s Neo-Liberal Laboratory, describes how this happened in great detail).

The question, of course, is whether we are really seeing a return to “pragmatic” financial regulation, or are getting a bunch of ideologically driven, vain, and inefficient policy responses aimed at pleasing an understandably disgruntled electorate. I think the current European attempt at imposing much stricter regulations on private equity and hedge funds in order to rein in “speculation” might be a sign of the latter. I find the argument that “speculation” is to blame for the financial crisis quite unconvincing (speculation can actually be stabilizing), I am pretty sure there have been some more fundamental structural dynamics at work. I will write more on this elsewhere.

The second area where actual policy has been heavily ideologically driven is development economics. More specifically, the kind of economic policies pushed on a whole range of countries by the World Bank and IMF as conditionalities and structural adjustment programs associated with various loans and aid packages in Latin America, Africa, and the former communist economies in Eastern Europe were arguably heavily laden with fundamentalist-like free-market ideology. In this policy area, through, the reversion to pragmatism described by Kaletsky had started happening before the financial crisis as a result of lacking growth and lots of financial crises in a range of countries where reforms were the heaviest; as well as the counterpoint of rapid and sustained growth in countries like China and India, which have been far from implementing anything like an IMF-style policy package. Nevertheless, the most recent – and global – financial crisis arguably made the glass spill by adding legitimacy to non-mainstream economics. The effect has been a dramatic and still ongoing turnaround in the World Bank and the IMF on what constitutes good and acceptable economic policy for developing/emerging-market countries. Most importantly this includes allowing governments to engage in active industrial policy, in particular to promote export growth and diversification, and prudent regulation of international capital flows.

As such, it appears that where the return to pragmatism from ideologically driven economic policy will matter most is in the developing world. If such pragmatism yields sustained economic growth, this is of course not without benefit for the West either. The world economy is like a big party, it is much better when everyone is having a good time.

And of course, economics will probably be a more interesting subject to study. At least I hope so.